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EASY Capital Budget: 1.

A firm should never undertake an investment if accepting the project would cause an increase in the firm’s cost of capital. FALSE PV of Cash Flows 2. Because present value refers to the value of cash flows that occur at different points in time, present values cannot be added to determine the value of a capital budgeting project. FALSE Ranking methods: 3. Given two mutually exclusive projects and a zero cost of capital, the payback method and NPV method of selecting investments will always lead to the same decision on which project to undertake. FALSE. Payback Period: 4. One advantage of the payback period method of evaluating fixed asset investment possibilities is that it provides a rough measure of a project’s liquidity and risk. TRUE NPV 5. Assuming that the total cash flows are equal, the NPV of a project whose cash flows accrue relatively rapidly is more sensitive to changes in the discount rate than is the NPV of a project whose cash flows come in more slowly. FALSE IRR 6. The internal rate of return is that discount rate which equates the present value of the cash outflows (or costs) with the present value of the cash inflows. TRUE 7. Under certain conditions, particular projects may have more than one IRR. One condition under which this situation can occur is if, in addition to the initial investment at time = 0, a negative cash flow occurs at the end of the project’s life. TRUE 8. Other things held constant, an increase in the cost of capital discount rate will result in a decrease in a project’s IRR. FALSE IRR and NPV 9. If a project’s NPV exceeds the project’s IRR, then the project should be accepted. FALSE Multiple IRRs 10. The phenomenon called “multiple internal rates of return” arises when two or more mutually exclusive projects which have different lives are being compared. FALSE MIRR 11. The modified IRR (MIRR) method has wide appeal to professors, but most business executives prefer the NPV method to either the regular or MIRR. FALSE 12. The MIRR always leads to the same capital budgeting decisions as the NPV method. FALSE Mutually exclusive Projects 13. Conflicts between two mutually exclusive projects, where the NPV method chooses one project but the IRR method chooses the other, should generally be resolved in favor of the project with the higher NPV. TRUE Reinvestment rate assumption 14. The NPV method’s assumption that cash inflows are reinvested at the cost of capital is more reasonable than the IRR’s assumption that cash flows are reinvested at the IRR. This makes the NPV method preferable to the IRR method. TRUE. Replacement Chain

Small businesses probably make less use of the DCF capital budgeting tecniques than large businesses. the financial manager should always select that project whose internal rate of return is the highest provided the project have the same initial cost. the choice of accounting method. Project Q has larger early cash flows than R. hence on the accept/reject decision under the IRR method. we can conclude that the firm will select X rather than Y if X has a NPV > 0. and both IRRs are greater than zerio. Any capital budgeting investment rule should depend solely on forecasted cash flows and the opportunity cost of capital. which could change the accept/reject decision for a potential project. FALSE Reinvestment rate assumption 25. The rule itself should not be affected by managers’ tastes. If the IRR of normal Project X is greater than then IRR of mutually exclusive Project Y (also normal). the NPV of X is greater than the NPV of Y at the cost of capital. FALSE 23. with large cash flows late in its life. while Project L has a longer life. provided we have confidence in the data. In capital budgeting analyses. Normal projects Q and R have the same NPV when the discount rate is zerio. normal projects S and L have identical NPVs. A decrease in the firm’s discount rate (r) will increase NPV. when used to evaluate an independent project. or the profitability of other independent projects. Also. Put another way. However. will lead to different accept/reject decisions unless the IRR is greater than the cost of capital. we know that at all discount rates greater than zero. project R will have a greater NPV than Q. TRUE 26. Other things held constant. such a change would have no impact on the project’s IRR. and the investment made. This may reflect a lack of knowledge on the part of small business firms’ managers. However. but it may also reflect a rational conclusion that the costs of using DCF analysis outweigh the benefits of these methods for those firms. TRUE IRR and NPV 21. it is impossible to draw NPV profiles that would suggest not accepting Project X. The NPV and IRR methods. TRUE
. or common life.15. The IRR of normal Project X is greater than the IRR of normal Project Y. Now suppose interest rates and money costs generally decline. this change will cause L to become preferred to S. FALSE Mutually exclusive projects 18. TRUE 17. Project X should definitely be selected. Therefore. If the two projects are mutually exclusive. The main reason that the NPV method is regarded as being conceptually superior to the IRR method for evaluating mutually exclusive investments is that multiple IRRs may exist. The replacement chain. At the current cost of capital. FALSE NPV versus IRR 22. FALSE MEDIUM Ranking methods 16. FALSE NPV 19. FALSE 20. Project S has a pattern of high cash flows in its early life. When considering two mutually exclusive projects. it is possible that NPV and IRR will both involve an assumption of reinvestment of the project’s cash flows at the same rate. FALSE NPV profile 24. approach is applicable whether two projects with differing lives are mutually exclusive or independent.

e. b. Statements a and c are correct. Which of the following statements is most correct? a. b. e. The NPV method does not consider the inflation premium. the initial cash flow isnegative. ProjectB has an IRR of 14 percent. and all other cash flows are positive). All of the answers above are correct. d. approach is appealing for dealing with projects with different lives. e. The NPV method assumes that cash flows will be reinvested at thecost of capital while the IRR method assumes reinvestment at therisk-free rate. Extending projects with different lives to a common life for comparison purposes.e. b. d. b. None of the answers above is correct. or common life. The IRR method does not consider all relevant cash flows. The NPV method assumes that cash flows will be reinvested at thecost of capital while the IRR method assumes reinvestment at theIRR. d.. a. Assume a project has normal cash flows (i. c. If the cost of capital were less than 12 percent. a. 34. Answers b and c are correct. c. b. If a project’s internal rate of return (IRR) exceeds the cost ofcapital. Although the replacement chain. c. All else equal. d. d. while theoretically appealing. b.
. Answers a and b are correct. c. All else equal. Graph problem 33. Which of the following statements is most correct? a. d. Both projects have a cost of capital of 12percent. 31. The NPV method assumes that cash flows will be reinvested at therisk free rate while the IRR method assumes reinvestment at the IRR. d. Ignores cash flows beyond the payback period. a project's IRR increases as the cost of capitaldeclines. Is useless as a risk indicator. a project's MIRR is unaffected by changes in thecost of capital. d.e. c. 32. b. The IRR calculation implicitly assumes that all cash flows arereinvested at a rate of return equal to the cost of capital. and particularly cash flows beyond the payback period. Both projects have a positive net present value (NPV). a. then Project A mustalso have a higher NPV. b. d. All else equal. a project's NPV increases as the cost of capitaldeclines. a.27. 30. Which of thefollowing statements is most correct? a. If Project A has a higher IRR than Project B. Project B wouldhave a higher IRR than Project A. it is not used in industry because there are no projects which meet the assumptions the method requires. Which of the following statements is most correct? a. TRUE EASY 29. should be done only if there is a high probability that the projects will actually be replicated beyond their initial lives. Only answers b and c are correct. e. Answers a and c are correct. c. c. then the project’s net present value (NPV) must bepositive. b. Does not directly account for the time value of money. Project A has an internal rate of return (IRR) of 15 percent. e. c. c. FALSE 28. A major disadvantage of the payback period method is that it a. e. Project A must have a higher NPV than Project B. b. d. c.

The project’s internal rate of return is greater than 12 percent. c. Project B has an IRR of 18percent. All of the above answers are correct. Project L has total. If the WACC is less than 18 percent. Further. The project’s modified internal rate of return is less than 12percent. a.000. b. d. since both have NPV profiles which are horizontal. Project B will always have ashorter payback than Project A. Didn’t translate well Project A has an IRR of 15 percent. To determine if a ranking conflict will occur between the two projects the cost of capital is needed as well as an additional piece of information. Their NPVprofiles cross at a discount rate of 10 percent. Project B will always have ashorter payback than Project A. 37. e. d. The NPV and IRR methods will select the same project if the cost of capital is less than 10 percent. Which of the followingstatements is most correct? a. If the WACC is 10 percent. Which of the following statements best describes this situation? a. c.
36. e. for example. c. undiscounted cash flows from Project L are $15. d. at a discount rate of 10 percent. b. c. e. Answers a and b are correct. 8 percent. Both projects are equally sensitive to changes in the discount rate since their NPVs are equal at all costs of capital. Statements a. followed by a series of positive cash inflows. b. while S has total undiscounted inflows of$15.
e. c. e. Assume that you are comparing two mutually exclusive projects. for example.000. e. Project L. If the WACC increases. b.000.000. All of the answers above are correct. The solution cannot be determined unless the timing of the cashflows is known. Eliminate potentially profitable but risky projects. b. b.000. c. Both projects have the same risk.
38. d. because it hasa higher IRR. The project’s WACC is 12percent and its net present value is $10. The post-audit is used to a. Project S should be selected at any cost of capital. a. undiscounted cash inflows of $16. e. The project should be rejected since its return is less than theWACC. d. c. Which project's NPV will be more sensitive to changes in the discount rate? (Hint: Projects with steeper NPV profiles are more sensitive to discount rate changes. Whichof the following statements is most correct?
.and the NPV of Project B will exceed the NPV of Project A. Improve cash flow forecasts. e. Which of the followingstatements is most correct? a. a. If the WACC is greater than 18 percent. c.e. Projects L and S each have an initial cost of $10. b. Project L should be selected at any cost of capital. d. Stimulate management to improve operations and bring results intoline with forecasts. both projects will have a positive NPV. Project S. A project has an up-front cost of $100. None of the above answers is correct. while the undiscounted cash flows from Project S total $13. d.
39. c.000. c.35. a. Neither project is sensitive to changes in the discount rate. the IRR of both projects will decline. and c are correct.
41. The total. d. Two mutually exclusive projects each have a cost of $10. d. The NPV and IRR methods will select the same project if the cost of capital is greater than 10 percent. b. b. because it hasa higher IRR.
40. a. b. b. d.000. the two projects have identical NPVs. 18 percent. If the WACC is 15 percent. the NPV of Project B will exceed the NPVof Project A.e.) a.000.

e. the initial cash flowis negative.d.b. Project X must have a highernet present value.b.e. Is similar to the yield to maturity on a bond. Project X has an internal rate of return of 20 percent.b. Answers b and c are correct.e. this will favor larger. Changes when the cost of capital changes. The MIRR method will always arrive at the same conclusion as the NPVmethod. a.
. None of the answers above is correct.d. Which of thefollowing statements is most correct?a. then NPV = 0.e. If a conflict exists between the NPV and the IRR. All else equal. b. a NPV/IRR conflict willnot occur. The NPV and IRR rules will always lead to the same decision unlessone or both of the projects are "non-normal" in the sense of havingonly one change of sign in the cash flow stream. c. b. Statements a. Overcomes the problem of multiple rates of return.
45. Assuming a project has normal cash flows. Which of the following statements is most correct?a. Answers a and b are correct.
46. Answers b and c are correct. c. shorter-term alternatives becauseit is good to earn high rates on larger amounts over longer periods.d.d. If IRR = r (the cost of capital).c. Which of the following statements is correct?a. All of the above statements are correct. Answers a and c are correct. a project's IRR increases as the cost of capitaldeclines. then the project must have a positive NPV. Which of the following statements is most correct? The modified IRR(MIRR) method:a.e. a.
47. d.c. The NPV method is not affected by the multiple IRR problem.e. The internal rate of return of a capital investmenta.c.
48. Both answers b and c are correct. If the cost of capital is relatively high.c. Statements a and c are correct. None of the above answers is correct. and c are true.c.42.
a.b.e. while the NPVmethod cannot. The NPV and IRR methods use the same basic equation. a project's MIRR is unaffected by changes in thecost of capital. The modified internal rate of return (MIRR) can never exceed theIRR. Compounds cash flows at the cost of capital.d. and even then. one or moreinitial cash outflows (the investment) followed by a series of cashinflows. Which of the following statements is mostcorrect?a. and all other cash flows are positive). Overcomes the problems of cash flow timing and project size thatlead to criticism of the regular IRR method. c. the NPV will be positiveif the IRR is less than the cost of capital. Project X must have a shorter payback than Project Y. a. then the smaller project willprobably be the one with the steeper NPV profile.. c. then Project Amust also have a higher NPV.and if their NPV profiles cross. the conflict canalways be eliminated by dropping the IRR and replacing it with theMIRR. b. Project X must have a higher net present value than Project Y. but in the NPVmethod the discount rate is specified and the equation is solved forNPV. If a project with normal cash flows has an IRR which exceeds thecost of capital.b. If you are choosing between two projects which have the same life.b. Which of the following statements is most correct? a. Assume a project has normal cash flows (that is. If the multiple IRR problem does not exist. All else equal. Project Y hasan internal rate of return of 15 percent. Both projects have apositive net present value. The MIRR method can overcome the multiple IRR problem. b. All else equal.b. The MIRR method uses a more reasonable assumption about reinvestmentrates than the IRR method.longer-term projects over smaller.c. There will be a meaningful (as opposed to irrelevant) conflict onlyif the projects' NPV profiles cross.d.e.d. Always leads to the same ranking decision as NPV for independentprojects. Is equal to the annual net cash flows divided by one half of theproject's cost when the cash flows are an annuity.d. Must exceed the cost of capital in order for the firm to accept theinvestment.
43. i. If the two projects have the same WACC. d. a project's NPV increases as the cost of capitaldeclines. If the cost of capital is less than the crossover rate for twomutually exclusive projects' NPV profiles.c. Which of the following statements is incorrect? a. If the IRR of Project A exceeds the IRR of Project B. Because discounted payback takes account of the cost of capital. Answers c and d are correct. any independent project acceptable by the NPV method will also be acceptable by the IRRmethod.
44.e.
49. aproject's discounted payback is normally shorter than its regularpayback. NPV can be negative if the IRR is positive. only if the costof capital is to the left of (or lower than) the discount rate atwhich the crossover occurs. while in the IRR method the NPV is set equal to zero and thediscount rate is found. b.

d. Statements a and c are correct. All of the statements above are correct. 56. irrespective of therelative sizes of the two projects. she forgot to labelthe profiles.b. then.c. Answers a and c are correct. in any meaningful.d. and both would be accepted if they were not mutually exclusive.c. and if their NPVprofiles cross once in the upper right quadrant. in the upper leftquadrant.c. However. Project D has a higher internal rate of return. Normal projects C and D are mutually exclusive.c. then there willprobably not be a NPV versus IRR conflict. All of the answers above are correct. Project C has a highernet present value if the WACC is less than 12 percent. which of the following statements is most correct?a. The discounted payback method solves all the problems associatedwith the payback method. The discounted payback method overcomes the problems that thepayback method has with cash flows occurring after the paybackperiod. Multiple IRRs can occur in cases when project cash flows are normal.b. the one with the steeper NPVprofile probably has less rapid cash flows. a.d. your assistantmust have made a mistake. None of the statements above is correct.000 andgenerates a positive internal rate of return of 9. All of the statements above are correct.d. Which of the following statements is most correct?a. Project A requires an up-front expenditure of $1. unless one or both ofthe projects are “non-normal” in the sense of having only one changeof sign in the cash flow stream.e.000. The project with the higher IRR may not always be the project withthe higher MIRR.200. 52. The project with the higher NPV may not always be the project withthe higher MIRR. at a discount rate of minus 10 percent. hence the project appears to have two IRRs. and if their NPV profiles crossin the lower left quadrant.000 andgenerates a net present value of $3. the pointat which the NPV profiles cross). In comparing two mutually exclusive projects of equal size and equallife.e. 51. You must now take her report to a board of directors meetingand present the alternatives for the board's consideration. then the one with the steeper profile probably has the lower initial cost. If the two projects' NPV profiles cross once. To helpyou with your presentation. When choosing between mutually exclusive projects.d.5 percent. Which of the following statements is most correct?a.7 percent. None of the projects above should be accepted.d. Project D is probably larger in scale than Project C.e.c. followed bya series of positive cash inflows. 55.b. the decision to accept or reject willalways be the same using either the IRR method or the NPV method. then one of the projects should beaccepted. 53. your assistant also constructed a graphwith NPV profiles for the two projects.e. However. The project with the higher NPV may not always be the project withthe higher IRR.e.50. If one of the projects has a NPV profile which crosses the X-axis twice. so you do not know which line applies to which project. Whenever a conflict between NPV and IRR exist.b. Two of the statements above are correct. whereas ProjectD has a higher net present value if the WACC exceeds 12 percent. Bothprojects have a positive NPV if the WACC is 12 percent.e. if the twoprojects have the same initial cost. Conflicts between NPV and IRR rules arise in choosing between twomutually exclusive projects (that each have normal cash flows) whenthe cost of capital exceeds the crossover point (that is.5 percent. If the two projects have the same investment cost. Project D has an internal rate of return of 9. For independent projects. a conflict which will affect the actual investmentdecision). Which of the following independent projects should thecompany accept?a. The IRR method is appealing to some managers because it produces arate of return upon which to base decisions rather than a dollaramount like the NPV method.c. Your assistant has just completed an analysis of two mutually exclusiveprojects.000. Project B has a modified internal rate of return of 9. which one is most reasonable? a. A company estimates that its weighted average cost of capital (WACC) is10 percent. If the two projects both have a single outlay at t = 0. All of the statements above are correct. at a discount rateof 40 percent. Project C probably has a faster payback. Project C requires an up-front expenditure of $1.d. 54.b.e.but they are more common in cases where project cash flows arenonnormal. One of the disadvantages of choosing between mutually exclusiveprojects on the basis of the discounted payback method is that youmight choose the project with the faster payback period but with thelower total return. Which of the following is most correct?a. Answers a and c are correct.Of the following statements regarding the profiles.c.b. this suggests that a NPV versus IRR conflict is notlikely to exist.
. if they haveidentical cash flow patterns. The NPV and IRR rules will always lead to the same decision inchoosing between mutually exclusive projects. practicalsense (that is. The Modified Internal Rate of Return (MIRR) compounds cash outflowsat the cost of capital. Which of thefollowing statements is most correct?a. managers shouldaccept all projects with IRRs greater than the weighted average costof capital.b.

and if their NPV profiles cross.000 5 CF 25.16 years 65. Statements a and c are true. The crossover rate for the two projects is less than 12 percent. Assume cash flows occur evenly duringthe year.d. What is the payback period for thisinvestment?a. 2. This
.3333 years iv. b. If you are choosing between two projects which have the same cost. would cost$500. A change in the cost of capital would normally change both aproject's NPV and its IRR.56 yearsc.54 yearsd. 60. 59. This investment will cost the firm $150.c. Project B has a highernet present value. Assuming that the two projects have the same scale.b. Theproject’s NPV is $75. i. which would be boughtimmediately (at t = 0). 2. Whatis the project’s simple. 67.000 4 CF 40. Michigan Mattress Company is considering the purchase of land and theconstruction of a new plant. b.12 yearse.000 in Year 10. 3.b. There can never be a conflict between NPV and IRR decisions if thedecision is related to a normal. Answers b and c are correct. 5.8763 years ii. When dealing with Independent projects.000 a year at the end of each of the next five years. and thatthis incremental flow would increase at a 10 percent rate annually overthe next 10 years. However.000 starting at the end of the second year.. and this fact is one reasongiven by the textbook for favoring MIRR (or modified IRR) over IRR. $35. e. and$40.000 per yearin Years 1 through 4. discounted payback (using apayback requirement of 3 or less years). and c are false. c. then the project with the higher IRR probably has more of its cash flows coming in the later years.000. we first compound CFs at the regular IRR to findthe TV. but those rankings canconflict with rankings produced by the discounted payback and theregular IRR methods.000 b. has a cost of $100.0000 years iii.86 yearsc. regular payback?a.22 yearsb. Answers a and b are correct. 63. It is estimated that the firm's after-tax cash flow will beincreased by $100.4793 years v.b. 4. 62.c. and then we discount the TV at the cost of capital to findthe PV. while Project Bhas an internal rate of return of 16 percent. IRR.d.000 and the company’s WACC is 10 percent.000 in Year10.000 per year in Years 5 through 9.35 yearse. 4 yearsc.000 and the building.000 today. if thecompany’s cost of capital (WACC) is 12 percent. whichwould be erected at the end of the first year (t = 1). 4. 10 years 64. Haig Aircraft is considering a project which has an up-front cost paidtoday at t = 0.e. Which of the following statements is correct?a. To find the MIRR. What is the approximate payback period?a.000 2 CF 100.e.c. 1/365th each day. 6 yearsd. Multiple rates of return are possible with the regular IRR methodbut not with the modified IRR method. 1. 2. The cost of capital is 10% what is the projects discounted payback? i. and modified IRRalways lead to the same accept/reject decisions for a given project. d. Statements a. Which of the following statements is most correct?a. 68.000 per year in Years 1through 4.d. 2. 8 yearse. 1. The land. 2. Project Aprobably has a faster payback than Project B. the MIRR method assumesreinvestment at the MIRR itself.57.000 1 CF 50. the NPV and modifiedIRR methods always rank projects the same. NPV willnever indicate acceptance if IRR indicates rejection. Lloyd Enterprises has a project which has the following cash flows: Year/ Cashflow a. $35.e.23 yearsb. Project A isprobably of larger scale than Project B. 2.00 yearsd. However. 4. 58. 4. 2 yearsb. The NPV and IRR methods both assume that cash flows are reinvestedat the cost of capital. Project A has an internal rate of return of 18 percent. The Seattle Corporation has been presented with an investmentopportunity which will yield cash flows of $30.6380 years 66. NPV. Which of the following statements is most correct?a. independent project. a.e.000 per year in Years 5 through 9. The Seattle Corporation has been presented with an investmentopportunity which will yield end-of-year cash flows of $30. and $40. Assuming the timing of the two projects is the same.000 3 CF 150.35 years 61. and the firm'scost of capital is 10 percent. When dealing with mutually exclusive projects. The project will generate positive cash flows of$60. 6. O CF -200.

000 today. If cash flows are evenly distributed and the tax rate is40 percent.306 for eight years.0%b. Value-based management focuses on sales growth. $52. and the cash flows occur at the end of each year. Two important issues in corporate governance are 1 the rules that cover the board’s ability to fire the CEO and 2 the rules that over the CEO’s ability to remove members of the board. and$2.415.000 per year for Years 6-8. 73.0%d.045d.0%c. what is the annual before-tax cash flow each year? (Assumedepreciation is a negligible amount.815.819. Ithas an estimated life of 10 years.investment will cost the firm $150.)a. $ 51.71 70.0%e.937.00 e. 14. $219. $38. If you require a 14 percent rateof return. $15. You have calculated a cost ofcapital for the firm of 12 percent. $ 92. 16. What is the project's MIRR?a. What is the NPV for thisinvestment?a. $1.138e.000 per year for Years 9 and 10. capital requirements.0% 72.000. $1.000 per year for Years 1-5. $5.000 and is expected toprovide after-tax annual cash flows of $73. 12. Alaska. $3. profitability.26 c. 17. then howmuch should you be willing to pay for this investment?a.. 71.
.984b. Free cash flows should be discounted at the firms weighted average cost of capital to find its operations. Alyeska Salmon Inc. a large salmon canning firm operating out ofValdez. The project has a cost of $275.983e.993b. Scott Corporation's new project calls for an investment of $10.321c. $4. $3. 15. $21. the weighted average cost of capital and the dividend growth rate. $135. Thefirm's management is uncomfortable with the IRR reinvestment assumptionand prefers the modified IRR approach.500d. $ 18.and the firm's cost of capital is 10 percent.146 69.023c.019
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The corporate valuation model cannot be used unless a company doesn’t pay dividends.85 d.27 b. You are considering the purchase of an investment that would pay you$5. $32. has a new automated production line project it isconsidering. The IRR has been calculated to be15 percent.000.